How to free up cash by reducing receivables
The most effective way to manage receivables is to put into place a system that allows management the ability to:
- Provide credit to eligible customers only
- Keep track of receivables in a timely manner
- Trigger follow-up calls/emails/letters for reminders/past due/legal action and
- Trigger when management intervention or legal recourse becomes the next action.
This allows for the majority of receivables to be managed in an orderly and efficient manner, while allowing problem accounts to surface immediately. If the system does not adequately address each step then receivables may become a major issue for the business.
Providing credit is a cash flow draining strategy for any business and should be viewed as a privilege provided to customers. A business may be able to expand revenue very quickly by extending lines of credit to customers that would have otherwise not been able to pay for items. Providing credit then becomes a risk-based decision and businesses should be aware that the risk may be passed on to external agencies such as credit card companies and financing institutions.
A business should make the payment experience as painless as possible for both the buyer and the business itself. If available, apply for credit card, debit card purchase, EFTPOS or PayPal as payment options.
Extending credit is therefore a decision that the business provides as a special case. To formalise this, assume that all customers that request credit terms first fill out a credit application form.
Creating a credit judgement criteria checklist
Once the business accepts the credit application form, a system will need to be put in place that allows for an evaluation of the potential customer’s ability to pay on credit terms. The business should therefore create a credit judgment criteria list.
One of the crucial points of the credit application form is the inclusion of credit references. It’s important to follow up each with a phone call to the referee. A lot of credit checking systems fail due to human error when credit referees are not followed up. Make sure this is part of the system and is adhered to by completing the credit judgment criteria checklist.
Advertising credit terms
If a business is putting itself in a position to shoulder the cost of providing credit then it should think carefully about using credit terms as an advertising or marketing tool. Doing so may have the unfortunate effect of draining cash reserves and the business should only do so if it is acutely aware of the net cash flow loss that providing credit terms will entail.
Certain industries may have their own peculiar ways of using credit terms as marketing tools. Here are some examples:
A retail business should outline its different forms of payment at the point of sale, on the website, and in brochures (where applicable). Small retail shops with larger competitors may have to contend with “store credit cards” and “gift vouchers”. To counter, make sure that all major credit cards are accepted and ensure that gift voucher checks are sold in the store as well. A small business may not be able to match store credit to retail customers and will probably not have the infrastructure required to do so. That said, a smaller business will be able to differentiate in other ways.
Professional and service industries
One of the major hurdles of professional and service firms is the charge per hour framework that so many businesses find themselves in. Turn this around by providing fixed price agreements and pricing up front as a marketing tool. This alleviates the seamlessly endless struggle of getting customers to agree to pay for hourly work and minimises the need to write-down invoices.
Credit terms are probably used most as a marketing tool in the manufacturing arena. This is where credit application forms have the most use and where businesses should take the most care in screening potential clients. Because capital requirements may be large with working capital tied up primarily in raw materials, receivables days becomes a crucial financial KPI to watch as well.
If credit terms become the only way a manufacturing firm is able to differentiate itself from the competition, then the business is putting itself at great risk. Work with the business to establish another point of differentiation such as delivery time, product customisation options, quality assurance. A business that does not differentiate in any of these arenas is purely a commodity and will be forced to fight on price and credit terms alone. A double hit as the first depletes net profit while the other depletes cash flow and working capital.